HOTCHKIS & WILEY Watch

Irving Kahn, along with brothers Alan and Thomas, founded Kahn Brothers (Trades, Portfolio) & Company, Inc., in 1978. The firm is a money manager and Registered Investment Advisor. Its principals manage approximately $1 billion of institutional and private funds.

Its portfolio is composed of 40 stocks and has a total value of $593 million and the following are the most heavily weighted trades the hedge fund closed during the Q2 2015.

The S&P 500 Index returned a modest +0.3% during the second quarter of 2015 and is now up +1.2% since the beginning of the year. Growth and value performed similarly during the quarter but value stocks have lagged considerably over the past 12 months. Typically, such environments present a headwind for our value-focused strategy but we have managed to navigate the past twelve months satisfactorily considering the circumstances. Naturally, however, we would welcome a value tailwind which our experience has taught us should inevitably emerge in due course.

The S&P 500 Index returned a modest +0.3% during the second quarter of 2015 and is now up +1.2% since the beginning of the year. Growth and value performed similarly during the quarter but value stocks have lagged considerably over the past 12 months. Typically, such environments present a headwind for our value-focused strategy but we have managed to navigate the past twelve months satisfactorily considering the circumstances. Naturally, however, we would welcome a value tailwind which our experience has taught us should inevitably emerge in due course.

The economic perils in Greece have reemerged as an important concern that is giving investors pause. The good news is that Greece is small, representing about 2% of the total economic output of all countries that use the euro as their currency. The primary risk for equity investors is that a Greek exit from the Eurozone sets a new precedent, and investors may ponder the possibility that a larger European economy (e.g. Italy, Spain) may share a similar fate if/when stressed, which could trigger economic turmoil throughout the region. Thus far, the market appears to perceive the Greece situation as largely quarantined—government bond spreads for other European periphery countries have remained relatively tight versus the German Bund. Nonetheless, we are monitoring the situation closely and have evaluated in detail each of our positions’ exposure to changes in the value of the dollar; we remain confident that we are not bearing unnecessary risk.

In its 35-year existence, value investor HOTCHKIS & WILEY has built its reputation on identifying undervalued companies that have great growth potential. But in the first quarter, most of its emphasis was on well-established companies, especially those in banking and insurance.

HOTCHKIS & WILEY‘s most significant new buy in the first quarter was its investment in 2,604,383 shares of Chubb Corp (NYSE:CB), a New Jersey-based property and casualty insurer. HOTCHKIS & WILEY paid an average price of $101.24 per share in a deal that had a 0.92% impact on the portfolio.

Following six years of positive returns, the S&P 500 Index opened 2015 with a modest +1.0% return in the first quarter. The unprecedented corporate cost-cutting measures and general economic recovery following the financial crisis has fueled impressive earnings growth. Over the last six years, the S&P 500 is up +194% cumulatively. While such a rampant appreciation of market prices would normally give us pause, equity valuations are scarcely higher than historical averages due to these robust earnings.

After six years of zero interest rate policy, investors are acutely focused on the Federal Reserve’s plan to taper its lax monetary policy. Equity investors are not fully insulated from such actions, however, we believe the effect on equities should be more subdued than many investors expect. Firstly, increasing interest rates are often correlated with positive economic developments, which is good for corporate cash flows. Secondly, long bond rates are a component of the cost of capital used to discount corporate cash flows. Fed tapering should impact short term interest rates disproportionately to long term rates, which already reflect expectations of a less intrusive Fed. Finally, the premium equity investors require above treasuries is considerably higher than historical averages. If interest rates rise, we may see a reversion of the equity premium back to normal levels, resulting in equity prices remaining stable despite higher interest rates.

Since its inception in Los Angeles in 1980, Hotchkis & Wiley (Trade, Portfolio) has focused exclusively on finding and owning undervalued companies that have a significant potential for appreciation. Hotchkis & Wiley are value investors focusing on important investment parameters such as a company's tangible assets, sustainable cash flow, and potential for improving business performance.

Last quarter, Hotchkis & Wiley increased its position in Navistar (NYSE:NAV) by buying 1,305,300 shares. In the previous quarters also, the investment firm was seen buying Navistar's shares. The following chart shows its holding history in the company.

Following six years of positive returns, the S&P 500 Index opened 2015 with a modest +1.0% return in the first quarter. The unprecedented corporate cost-cutting measures and general economic recovery following the financial crisis has fueled impressive earnings growth. Over the last six years, the S&P 500 is up +194% cumulatively. While such a rampant appreciation of market prices would normally give us pause, equity valuations are scarcely higher than historical averages due to these robust earnings.

After six years of zero interest rate policy, investors are acutely focused on the Federal Reserve’s plan to taper its lax monetary policy. Equity investors are not fully insulated from such actions, however, we believe the effect on equities should be more subdued than many investors expect. Firstly, increasing interest rates are often correlated with positive economic developments, which is good for corporate cash flows. Secondly, long bond rates are a component of the cost of capital used to discount corporate cash flows. Fed tapering should impact short term interest rates disproportionately to long term rates, which already reflect expectations of a less intrusive Fed. Finally, the premium equity investors require above treasuries is considerably higher than historical averages. If interest rates rise, we may see a reversion of the equity premium back to normal levels, resulting in equity prices remaining stable despite higher interest rates.

The debate over active versus passive investing has spurred numerous studies, which in turn, have produced many thoughtprovoking theories on the subject. Despite countless data, sophisticated statistical techniques, and brilliant researchers tackling the issue, there are few palpable and universal conclusions one can draw from these studies. This is somewhat predictable given that these studies use unique data sources, evaluate different periods, and employ diverse statistical methods—not to mention are subject to human biases. As such, we are not brash enough to claim that we could conduct a better study as we would be subject to these same shortcomings, including our own biases. Rather than recreate analysis that has been recreated many times over already, we are going to focus on the few common findings from these studies that appear to be largely undisputed. We will first describe these conclusions, illustrate why they exist, and then explain why we believe markets are inefficient and why active management can add value net of fees.

Hotchkis & Wiley, a Los Angeles-based investment firm, has been successfully managing portfolios for more than 30 years. In 2013, its investment advice yielded a 39.95% return for its clients, more than double its performance in 2012.

The S&P 500 Index returned +13.7% in 2014, its sixth consecutive positive year—the longest such streak since the mid to late 1990s. Unlike the extended bull market of the 1990s, which was driven by irrational growth expectations and swelling price-to-earnings multiples, the stock market’s rise over the past six years has been powered by broad corporate earnings growth. Moreover, household debt has been reduced by about 25% and corporate debt has been more than halved—an unprecedented deleveraging cycle that has de-risked the market considerably. Stock prices are up, earnings are higher, balance sheets are stronger, interest rates are lower, and inflation remains subdued. The U.S. economy has demonstrated clear progress though growth in Europe, Asia, and emerging markets has somewhat disappointed. Taking into account the confluence of these factors, we find the broad equity market reasonably valued for the risks at hand; it is neither especially compelling nor overextended. We have identified valuation opportunities selectively, as demonstrated by the portfolio’s discount to the market, but we remain highly reluctant to assume undue risk. The portfolio trades at 9.6x our estimate of normal/sustainable earnings compared to the S&P 500 Index trading at 16.6x normal earnings and 17.2x next year’s consensus earnings. We remain keenly focused not only on valuation support as a primary risk control, but also on strong balance sheets, sustainable cash flows, and prudent use of capital.

The S&P 500 Index returned a modest +1.1% over the three months ended September 30th, the seventh consecutive positive quarter for the index. In August, the index closed above 2,000 for the first time, peaking at 2,011 in mid-September before a slight pullback. Unlike prior market peaks (e.g. 1999, 2007), elevated stock prices today are supported by both strong corporate earnings and an improving economic environment. At 16.5x forward earnings, the S&P 500 Index trades at a valuation slightly higher than the 25-year median of 16.0x. Meanwhile, the 10-year Treasury yields 2.5% versus the 25-year median of 4.8%; considering the low interest rate environment equity valuations appear reasonable. The U.S. housing market continues to recover, with new home sales considerably higher than consensus expectations and home prices on the rise. Higher home values create a wealth effect that boosts confidence and drives consumer spending, which accelerated during the quarter—consumer spending comprises two-thirds of U.S. GDP, so the housing market’s economic impact is material. Meanwhile, employment has steadily improved and inflation has remained in check. The U.S. dollar strengthened as a result of the productive economy, appreciating by more than 6% relative to a basket of major developed market currencies1. While the tense geopolitical landscape poses risks to the equity market, the earnings power of our portfolio holdings provides considerable valuation support. The portfolio trades at 10.8x our estimate of normal/sustainable earnings, a significant discount to the market average2.

Concerns about decelerating growth in emerging markets triggered a precipitous decline in commodities over the quarter. Crude oil, natural gas, precious metals, most industrial metals, and most agricultural commodities declined considerably—some by more than 10%. Consequently, sectors exposed to commodity price changes lagged the overall market. Energy, utilities, and industrials were the only three S&P 500 sectors that declined during the quarter. Healthcare, technology, and telecommunications were the top-performing sectors, rising +3% to +5%. Value underperformed growth for the quarter, largely because energy is a larger weight and technology a smaller weight in value indices as compared with growth indices. Small cap stocks lagged large cap stocks by a wide margin in the quarter3. As of one year ago (9/30/13), small cap equities had outperformed large cap equities by more than 50 percentage points since the market bottom in March of 2009. This resulted in a large valuation premium for small cap stocks relative to large cap stocks compared to historical averages—this premium has eroded over the past twelve months toward levels more typically observed because small cap stocks have since underperformed.

In this article, let's take a look at News Corporation (NASDAQ:NWSA), a $9.1 billion market cap company, which is a diversified media company that has interests in newspapers, books and sports cable programming, and operates online properties, primarily in the United States, Australia and the United Kingdom.

On our October 22nd webinar, Mark Hudoff, portfolio manager of the Hotchkis & Wiley High Yield strategy, discussed the changing high yield environment and its impact on investors. The following recap highlights his views.

The S&P 500 Index returned a modest +1.13% over the three months ended September 30th, the seventh consecutive positive quarter for the index. In August, the index closed above 2,000 for the first time, peaking at 2,011 in mid-September before a slight pullback. Unlike prior market peaks (e.g. 1999, 2007), elevated stock prices today are supported by both strong corporate earnings and an improving economic environment. At 16.5x forward earnings, the S&P 500 Index trades at a valuation slightly higher than the 25-year median of 16.0x. Meanwhile, the 10-year Treasury yields 2.5% versus the 25-year median of 4.8%; considering the low interest rate environment equity valuations appear reasonable. The U.S. housing market continued to recover, with new home sales considerably higher than consensus expectations and home prices on the rise. Higher home values create a wealth effect that boosts confidence and drives consumer spending, which accelerated during the quarter—consumer spending comprises two-thirds of U.S. gross domestic product, so the housing market’s economic impact is material. Meanwhile, employment has steadily improved and inflation has remained in check. The U.S. dollar strengthened as a result of the productive economy, appreciating by more than 6% relative to a basket of major developed market currencies1. While the tense geopolitical landscape poses risks to the equity market, we believe the earnings power of our portfolio holdings provides considerable valuation support. The portfolio trades at 10.8x our estimate of normal/sustainable earnings, a significant discount to the market average2.

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